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Importance of income elasticity to firms

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In any economy, the levels of incomes of the population determine the level of demand of commodities produced and made available in that economy. The higher the income, the higher the demand of commodities and vice- versa when there is low incomes. Income elasticity is when income affects demand. This happens when income is increased in which certain goods such as inferior goods, the demand decreases. As for normal goods, the quantity demanded increases when income increases which in this case is regarded as “positive income elasticity.” Conversely, the quantity demanded for inferior goods decreases when income increases and this is referred to as “negative income elasticity.” Meanwhile, there are some normal goods which are taken as necessities which will have small income elasticity because these goods are necessary to our lives and people still need them though the income might be low (Mike, 2013, 19:10). The income elasticity is very important to firms in that it helps them to determine the kind of goods to produce at a particular time following the rooming income. Consequently, prices of goods will too, be determined in proportion to demand of such goods which is equally determined by the levels of income. It also allows firms to know the kind of employees to keep in employment as some firms look at rates of income of employees, for instance, long serving employees would attract higher income rates which some companies would be against. This publication will explain the importance of income elasticity to firms.

Mike (2013: 19:10), asserts that the “Income Elasticity of Demand” measures the rate of response of quantity demand due to a raise (or lowering) in a consumers income. This implies that the responsiveness of the demand for particular goods to a change in the income of the people demanding the goods, ceteris paribus. It is calculated as the ratio of the percentage change in demand to the percentage change in income. Therefore, Income elasticity of demand= (percentage change in quantity demanded)/ (percentage change in income). Mike noted that income elasticity of demand impacts on demand due to income. Since incomes keep increasing over time, so the demand pattern for various goods and services keeps changing. This matters for new firms looking to move into the market and produce something: the market for what goods or services is likely to grow the fastest? That’s the area to be in! It matters for existing firms looking to diversity, or be concerned about the prospects for the future in the area they produce and sell in. Income elasticity is important to firms because it enables the firms to determine how much consumers will pay for products they will produce. The firms make business decisions using the concept of income elasticity. Rick (2013) indicates that the income elasticity measures the relationship between sales and consumers’ incomes, according to business expert, Graeme Pietersz, at Moneyterms.co.uk.

He further asserts that this can be highly evident during economic recessionary periods. People have less disposable income during recessions. Some may not have jobs at all. Hence, companies need to center their marketing strategies and decision making around the statuses of consumers’ incomes. The income elasticity affects some products and according to Rick, the consumers usually take care of their basic needs when income elasticity is high. For example, people need food, water, shelter and personal-care items. However, consumers often cut back on luxury items when their incomes are limited. Rick made an assertion that firms would offer some incentives in form of discounts, long-term payments or “no money down” deals so as to attract buyers. Small food companies need to lower prices to compete with generic brands, items consumers often buy during tough economic periods. Another importance of income elasticity to firms is that higher revenues and profits may be realized as noted by Rick (2013) in his publication, “The importance of income elasticity in decision making” that a strategy for a small companies is to focus marketing efforts on higher-income consumers when consumer income elasticity is high as individuals may be less sensitive.

When income elasticity is high, adopters and innovators may shop these products making these firms to earn higher revenues and profits. Income elasticity will also make firms to engage into product life-cycle management though challenges come as a product ages and more substitutes are introduced. When this happens the firm will diversify its product line to attract consumers with less disposable income. Consequently, income elasticity will enable firms to make decisions whether to down size labour as consumption- demand falls for their products and services especially in recessionary periods as cost of production may be unbearable. Meanwhile, income elasticity of demand can be generally used as an indicator of industry health, future consumption patterns and as a guide to firms’ investment decisions (Frank, Roberts, 2008, p.125).


Businesses make decisions whether to diversify their product and services, maximize or cut down production, strategize marketing and advertising seeking to woe consumers, branding and packaging strategies to spur sales, relocate business, and decide on the type and number of employees required at a given time period following income elasticity of the population and economy as a whole. Firms are enabled to determine the price of their products and what to be supplied with through the observance of income elasticity. Furthermore, businesses of all sizes utilize the concept of income elasticity of demand to determine how consumers are likely to respond in terms of demand for their products when some type of income shift takes place (Malcolm, 2013). It is therefore important that a firm applies income elasticity concept in order to remain focused and steady fast in business especially in this competitive and unpredictable economic situations.

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